April 2018 Flanagan - EIC Federation

EIC meeting Vienna 20th April 2018 ‐ Roger Flanagan

April 2018

International construction - it’s all about competitiveness

Roger Flanagan – University of Reading

Competitiveness

•Competitiveness is fundamental to success; creating new forms of competitive advantage is key•New players are not hidebound by the traditional competitive models • It’s a fast changing world with the speed of change increasing•Uncertainty and risk is the problem, in construction we are hidebound by illusions of certainty, then wonder why it went wrong•Understanding the DNA of the competition is very important

Creating competitive advantage in construction

• Lowest price• Consistent high quality• Customer focused, the customer is King• Good record for safety and health• Capable of speed of delivery• Providing the most attractive project financing

package, and guarantees• Design capability and the capacity to integrate

design and production• Having off-site production facilities and capability

to increase speed of production• Strong balance sheet• Appetite for risk

Creating competitive advantage in construction

• Record of corporate social responsibility• Political support from government through

project creation and export guarantees

CluelessYou don’t know what you don’t

know

Discouragingly realistic

You know what you don’t know

Naively confidentYou think you know, but still

don’t knowwhat you don’t

know

Mastery achievedNow you need to stay competitive

Looking at competitiveness

OptimisticYou feel confident about

your strengths against the competition

The construction sector is trying to fly a Dakota at supersonic speed with systems and procedures that were never designed for speed or turbulence now encountered on construction projects


April 2018

Innovators, at least they tried

Using the analogy of the aircraft industry

Speed

Early days Precision formation

Getting it wrong

Heavy lifting Difficult manoeuvres

Technology

Comfort

Fuel and power = money/project finance

Operating crew = management team

Performance of the aircraft = productivity

Passengers = client

Navigation = form of contract agreement

Take off = bid stage and tender

Landing = practical completionTimetable = planning

production on site

Landing gear/fit out = specialty contractors

Design and production of the aircraft is integrated = independent design team consultants design construction projects for a fee

Designed for weather uncertainty with turbulence, wind shear, typhoon, etc. = illusions of certainty in construction, and clouds of uncertainty and risk in construction, often not well forecast

• The separation of design and production in construction was never designed for today’s complexities, rules, and regulations that thrive on bureaucracy, and liability

• The bidding/tendering system is broken, pricing incomplete information is unrealistic, no plane would fly without full information

• Construction project costing systems are historical, not dynamic• Cash flow has become critical with payment systems designed for the

old world of construction where direct employment was common (without fuel the plane crashes)

The construction sector does amazing things with outdated systems and procedures – we need to move on

Constant changeWith the rate of change in the local and national construction market and the rapid advancement in globalisation and technology, tomorrow will not be the same as today

Four or five decades ago, market reactions were more predictable

The challenge is that many of the” traditional systems” used in the industry today were designed for a more predictable industry that was not subject to constant change

Turmoil is not new


April 2018

• Greater risk and more uncertainty• More complexity• Failure of systems linked to outdated ideas• Increasing prices caused by uncontrollable events• Emergence of China as a major power in international construction• Clients demanding better value for money• Digitisation breaking down professional barriers• Demand for social responsibility and accountability

2008

Accountability replacing trust

To this . . .From this . . . . .

Peak of inflated expectation

Plateau of performance

Trigger of enlightenment

Trough of disillusionment

Slope of new enlightenment

Where is the European construction sector on the scale of enlightenment?

Europe

Bole International Airport, Addis Ababa, Ethiopia

Will Chinese companies continue to be competitive in Africa and Latin America?

Global Construction Output

Markets

Updated 2018

2017 Global annual construction output ≈ US$8.2 trillion+ professional services + local taxation + informal sector

All figures are annual output in current US$ billion (2017) – not gross value added

Exchange rate differences will have a significant effect on the output figures

Canada100

USA1273

Latin & CentralAmerica

500

Africa150+

Europe1806

China2868

Russia107

India332

Japan431

Korea182

Malaysia 46

Australia164

The Gulf105

Hong Kong31

Ireland15

Brazil120

Output is around 30% infrastructure and 30% housing

Some of the annual output data are not reliable because of data collection difficulties in some countries and the lack of recording for the informal sector

Nigeria 21.4South Africa

9.6Ethiopia 7.5Angola 7.5Tanzania 5.4

Saudi Arabia45

Pakistan 6

Markets are cyclical with very different structures, localised and regiocentric. It is not a homogeneous market. Today’s markets are characterised by a shark’s fin, not a bell shaped curve

The visible and invisible barriers to entry are different. Some markets are closed

The speed of the market collapse in many markets is faster than the climb for recovery

Shift in centre of gravity to different markets


April 2018

The state of construction around the world

The developed world faces: efficiency/productivity/cost/quality challenges•Demand for more efficient infrastructure services•Ageing infrastructure, the need for repair, upgrading, replacement•Climate change•Growth of megacities•Integration of service for more resilient infrastructure•Better value for money in infrastructure delivery•Higher quality•Projects running over budget and over time

The developing world : efficiency/ capacity building/cost challenges•Rapidly increasing urbanisation•Demand for resilient infrastructure•Climate change•Growth of megacities•Challenge of bankable projects•Growing populations•Over reliance upon foreign aid and finance•Lack of capacity building in the construction sector•Corruption

Annual spend per capita in construction: Pakistan US$70, Nordic countries US$4,000

What characterises construction around the world

Consolidation - the big consultants and contractors are getting bigger through mergers and acquisitions

The construction sector is one of the most important industry sectors for every country, few governments really understand the dynamics of the sector

Big differences in the spend per capita in construction across the globe- around US$3,000 per capita in the developed world, around US$100 in parts of the developing world

Projects are getting bigger with more megaprojects, more PPP derivatives, and more demanding clients

More complexity, more risk, and some disillusionment - need to change the delivery mechanism for design and production to give cheaper, safer, and higher quality

What characterises construction around the world

The importance of safety and health, changing the culture in the industry to behaviour based safety

The challenges of corruption in its different guises

Localisation, local jobs for local people, local content

Need to improve productivity on the job site

“One Belt, One Road” initiativeThe “Silk Road Economic Belt” and “21st Century Maritime Silk Road”, initiatives first introduced by Xi Jinping in the fall of 2013 New regional institutions, such as the Asian Infrastructure Investment Bank (AIIB) and New Silk Road Fund (NSRF), are designed in part to complement and support the Belt and Road’s developmentThe Belt and Road will improve China’s internal economic integration and competitiveness and spur more regionally balanced growth

US$1.36 trillion investment

The Silk Road Economic Belt is envisioned as three routes connecting China to Europe (via Central Asia), the Persian Gulf, the Mediterranean (through West Asia), and the Indian Ocean (via South Asia)

Geopolitical initiatives creating opportunities for the construction sector with China in control

Chinese workers at a tunnel being created near Vang Vieng, Laos. Part of a US$6 billion project that will connect eight countries

Security is a big issue, 44 workers have been killed in attacks by Pakistan militants on road projects

US$62 billion investment in CPEC


April 2018

Some mythology and some big questions on competitivenessAll the Chinese companies behave the same, they use low cost, low quality labour, working in poor conditions. There is no point in trying to compete with them on price in Africa, Latin America, and other parts of the developing world

The Chinese model is changing, their labour and overhead costs are escalating rapidly, labour is becoming more expensive and more demanding. Chinese companies are acquiring local companies, and seeking investment opportunities as is happening in the USA, Canada, Australia, and New Zealand

African and developing world countries are only interested in low cost, not best value

Corruption in India, Bangladesh, and Pakistan is endemic, yet the Chinese companies seem capable of playing the game

Wrong decision

Slowly, but surely, the message is getting through –quality counts. It won’t happen overnight

China wants to change the game as well. The State Owned Enterprises are not the same as the Chinese private companies

Chinese companies are building a new competitiveness model with investment, and professional services in the mix

Complexity

Risk & uncertainty-more clouds of uncertainty

Convergence

Disruption and change

FOUR ISSUES IMPACTING CONSTRUCTION COMPETITIVENESS

Change is happening fast, we have moved from incremental change to continuous change

Acceleration and speed of change

Who would have believed 5 years ago that:

…. and sells their

Infrastructure and Building business for

US$84 million to a Black-Empowered company

…. and sells their

Infrastructure and Building business for

US$84 million to a Black-Empowered company

Africa’s largest international construction company exits constructionAfrica’s largest international construction company exits construction

SOUTHERN PALACE GROUP-LED CONSORTIUM ACQUIRED MURRAY AND ROBERTS’ INFRASTRUCTURE AND BUILDING BUSINESS

The fully-funded purchase consideration is R314 million. Murray & Roberts CEO stated “This supports our long-term strategy and creates the first major black-owned infrastructure business in South Africa.”

1st Nov 2016

A multinational specialist

engineering and

construction group focused on the natural

resources market sector

1902‐2017

Disruption and Change

Part of a settlement between the government and SA’s seven largest construction and engineering groups for their part in collusion in the run-up to the 2010 Soccer World Cup, which required them to sell at least 40% of their domestic infrastructure businesses to black empowerment partners, or to mentor up to three black construction companies over a period of seven years.

Net loss of R347 million- Restructuring

5 largest South African construction companies are restructuring following losses


2016 Loss before tax €445 million2015 Loss before tax €119 million

One of the largest Spanish contractors

After four decades of building some of the country’s iconic structures. Saudi Arabia, Saudi Oger ceased trading on July31 2017


Declared bankrupt (Jan 2018), debts of £1.5 billion, taking specialist contractors with them

Declared bankrupt, failed to pay workers for six months

UK largest construction firm.Turnaround from loss to small profit (declared March 2018)

Sold the concessions business stream to provide cash (Dec 2017)


April 2018

The South Pacific’s largest construction company, Fletcher Construction is withdrawing from building projects following profits warnings and losses of NZ$454 million in 2017, and NZ$292 million in 2016

China State Construction enters the New Zealand market with major projects for Chinese investors

Odebrecht, the largest engineering and construction contractor in Latin America with 128,000 staff fined US$3.5bn for bribery and corruption.

Now being restructured


Odebrecht had a department dedicated to bribes, known as the Division of Structured Operations. Half the company’s workforce has been laid off

Andre Gutierrez and OAS , two of Brazils largest construction enterprises also embroiled in Operation Lava Jato (Car Wash)

OAS had 100,000 staff, files for bankruptcy protection and restructuring

Company being restructured. Fine still outstanding, originally seeking was US$12 billion, but recognising it would bankrupt the company!

Founded 1948

CCCC acquired John Holland in Australia for US$642 million to become a major player in building and infrastructure delivery in Australia


China's CCCC Buys Aecon for CAN$930 Million in Canada Nov 2017

ConvergenceConvergence of design and production will increase performance and productivity, BIM

Convergence of information across the life of the project, whole life thinking

Convergence of technologies, ICT, Auto-ID, internet of things

Convergence of design, manufacturing, and construction production (off-site production)

Convergence of companies, the barriers between contractor and pure play consultant is changing, the assumption that big is best

Convergence of disciplines with more integration across disciplines

Health & Safety

Bidding

Design Environmental

Compliance

Cyber security

SecurityWeather

Technological

Political Corruption

Balancing the risks

Reputation

Risk and Uncertainty

Pakistan


April 2018

Very rarely are they linear and it is difficult to forecast at the bid stage Path dependency is an

important aspect of risk

Risks have a unique sequence, rather like DNARisk and uncertainty

Accumulation risks

Trigger

Risk

The problem with risk is non-linearity, interconnected events bounded in complexity

The traditional methods of managing big projects were not designed for current risks and such dynamic

interconnectivity

Swiss cheese model – gaps created across the supply chain and project time horizon

ComplexityEverything we do has become more complex

THREE PROPOSITIONS

PROPOSITION 1CREATING COMPETITIVE ADVANTAGE IN THE INTERNATIONAL CONSTRUCTION MARKET HAS CHANGED

Design and engineering professional service firms will increasingly move into the construction/production space

Chinese construction firms are benefitting from the close links between investment/finance, political influence, and construction. They are becoming more efficient, also more productive with new digital technologies. The best are very good, the weak are very poor

European construction enterprises must respond by changing the delivery model by embracing the supply chain in a different fashionWe make a decision based on price, quality, safety, technical advantages, specialization, social responsibility

NEW MODEL FOR COMPETITIVE ADVANTAGE IS NEEDED

Unclogging the pipeline of work

Consolidation across the engineering and construction sector

The 2017 Top International Contractors 2017

17 of the top 50 are from China


April 2018

Emerging National Regional

Time

Scal

e/si

ze

Mega

Vinci (France)Bouygues (France)Skanska (Sweden)CSCEC (China)CCCC (China)China Rail (China)China Railways (China)Power China (China)Ferrovial (Spain)Hyundai (Korea)ACS (Spain)Odebrecht (Brazil)Bechtel (USA)Fluor (USA)Technip (France)Samsung (Korea) Salini Impregilo (Italy)

Contractor clustersShimizu (Japan)Takenaka (Japan)Taisei (Japan)Kajima (Japan)Obayashi (Japan)Multiplex (Australia)GS (Korea)Balfour Beatty (UK)Gammon (Hong Kong)Sunway (Malaysia)Jan de Nul(Luxembourg)Sumitomo Mitsui (Japan)Royal BAM (Holland)CIMIC (Australia)Beijing Constr. Eng(China)McConnell Dowell (Australia)Orascom (Egypt)Odebrecht (Brazil)FCC (Spain)Enka (Turkey)Arabtec (UAE)Besix (Belgium)Aveng (South Africa)HLG (UAE)

Kiewit (USA)Hindustan (India)Larsen & Toubro (India)Veidekke(Norway)NCC (Sweden)

TurkishContractors

Private Chinese contractors

Russiancontractors

A gap is emerging between the best and the rest

China understands specialist design and installation

The importance of design

What characterises engineering and design consultants?

Consolidation – mergers and acquisitions with the big getting bigger

Diversification into engineering sectors, such as aeronautical, automotive

Scale, some have become too big to survive as an independent design consultant selling soft services

Geographical spread

What characterises engineering and design consultants?

Integration of design and production

Asian consultants getting a wake up call

More commercial, desire for profitability

Embracing digital engineering

Design Production

Rise of the Starchitect

Absence of Chinese consultants, but that will change

Starchitects/designers have been successful in winning major projects, they developed reputations for design excellence and project delivery

There are very few big name China designers


April 2018

Consolidation across the design and engineering sector

The 2017 Top International Design companies

CH2M now part of JacobsDAR Group share ownership in Worley Parsons

No pure play Chinese consultants are in the top 50 (one contractor (CCCC)

Emerging Boutique Regional

Mixed mode

Mega

Time

Jacobs (USA)AECOM (USA)Arcadis (Holland)WSP (Canada)Egis (France)Rambøll (Denmark)Surbana Jurong (Singapore)DAR (Lebanon)SNC Lavalin Atkins (Canada)Arup (UK)Systra (France)Royal Haskoning (Holland)Mott MacDonald (UK)Fugro (Holland)Worley Parsons (Australia)Stantec (Canada)Sweco (Sweden)Aurecon (Australia)Nippon Koei (Japan)

Bechtel (USA)Fluor (USA)Technip (France)Hyundai (Korea)Ozburk (Turkey)CSCEC (China)Power China (China)Sinopec (China)CCCC (China)

National players specialising in niche markets

IDOM (Spain)Poyry (Finland)Cowi(Denmark)Khatib and Alami(Lebanon)Black & Veatch (USA)AF (Sweden)Samoo (Korea)Ayesa (Spain)Fichtener(Germany)Typsa (Spain)ACE (Greece)Italconsult(Italy)Norconsult(Norway)Tata (India)Botek (Turkey)BAC (Spain)

Chinese Design institutesStrong national players

Engineering consultant clusters

A gap is emerging between the best and the rest

UnderstandWe need a much better understanding of the DNA, the drivers, and the business model of the competition. Do not assume that because they are a contractor, they have the same systems and approach.

Embrace co-opetitionDevelop a different approach to dealing with the Chinese competition. Embrace and use their supply chains, look at collaboration with suppliers, manufacturers, and component teams. Embrace co-opetition.

Change the game plan

PROPOSITION 1

PROPOSITION 2 is about gaps

PROPOSITION 2 CLOSE THE GAP BETWEEN DESIGN AND PRODUCTION PROCESS TO MAKE THE TRADITIONAL BIDDING MODEL LESS DYSFUNCTIONAL

Reliance upon international design and engineering consultants to produce workable designs

Lack of integration

Clouds of uncertainty

Low profit margins internationally in production

Higher client expectations

Shortage of skills

BIDDING

More riskMore complexity

Illusions of certainty

The conflict in bidding is between clouds of uncertainty and illusions of certainty

Top global contractors – revenue and profit margin before tax

(Billion USD)

ACS Bouygues Vinci Skanska Strabag Ferrovial Hyundai Shimizu CSCEC CCCC

(China)(China)(Japan)(S.Korea)(Spain)(Austria)(Sweden)(France)(France)

(Spain)

Revenue

Profitability

Construction DivisionInternational Revs. 2016 Domestic Revs. 2016

Net income margin 2015(% on Revs.)

Net income margin 2016(% on Revs.)

16%

84%

6.5

34.6

45%

55%

6.6

18.5

8.3

41%

59%

58%

9.9

7.1 42%(Nordic)

10.4

84%16%2.3

9.676%24%

3.0

8.5

52%48%

12.4

89%

1.611%

122.7

93%

7%9.2 11.3

83%

17%

53.4

2.05%

2.3%

2.91%

2.76%

5.31%

6.57%

3.13%

3.94%

1.38%

2.27%

5.94%

5.72%

1.92%

2.61%

2.13%

3.56% 2.82

%2.85%

3.92%

4.00%

(source: annual report and accounts) Such low margins are not sustainable in the long term


April 2018

We need to fill the gap at the bid stage between design and production, with new approaches and a more systemised approach towards estimating

Treat the bid phase as the most important part of the whole process

Too little time allowed for bidding

Unreliable information of variable quality

Cost of bidding is increasing

Loss of deep knowledge base in estimating

Greater reliance upon specialty contractors

DesignBid

Production

The risks are increasing and the risk allocation is causing problems

Expensive bid submissions on large projects including simulations

PROPOSITION 3 COMPETING ON A LEVEL PLAYING FIELDThis is how we are all playing at the moment in the developing worldEven the developed world pitch is getting bumpier

We need to think about how we compete in the dynamic and changing market. There needs to be a level playing field with a new rule book for delivery

Quality

Social responsibilityEnvironmental responsibility

Ethics and compliance

Safety and health

Code of behaviour for interim and final payments, retention payments, and final account settlement

Looking after the customer

Managing and protecting information and data

April 2018 Flanagan - EIC Federation

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